The EU Referendum: Leave or Remain?

It seems like many people are baffled by which way to vote in the EU referendum. Neither the Remain or Leave campaigns have done much to educate people on the subject. Instead both have sought to win the numbers game. We have been bombarded with migration statistics and economic forecasts, but we have been short on moral arguments. We have been given hyperbole and fear-mongering rather than substantive debate. We have been given Boris and Cameron, rather than listening to academic economists or political scientists explain the pros and cons to ordinary people. I decided to give my thoughts on the subject, in the hope that it might shed some light on the choice we have to make on the 23rd.

(I wanted to make this article accessible to those without much interest in politics or economics, so apologies if this means it seems patronising, or as stating the obvious, to any of you who are educated in these fields.)

Why have a free trade area in the first place?

Let’s get the boring bit out of the way early. Free trade is assumed to maximise output. The GDP of the free trade area as a whole should increase as a result of trading without restrictions. The father of modern economics, Adam Smith, came up with his theory of absolute advantage in 1776. It stated that each country should specialise in producing whatever they produce most efficiently, then trade with one another. The idea is that if the UK, for example, could produce wheat more efficiently than the French, and France could produce cloth more efficiently than the British, then any resources the UK is currently using to make cloth would be better spent on wheat. Likewise France should cease trying to grow wheat and put those resources into cloth, and then trade with the British. This way, the production of both wheat and cloth could be maximised.

In 1817 David Ricardo built upon Smith’s work, calling his new theory comparative advantage. Ricardo showed that production could be maximised through trade even if one country produced both goods more efficiently. It should, according to Ricardo, specialise in those goods in which its relative efficiency was greatest. So, for example, if the UK produced both wheat and cloth more efficiently than the French, but had a greater efficiency margin in wheat, then it should still transfer the resources it uses to produce cloth into wheat production, and leave cloth to the French. Clearly this is an extremely simplified example, but if the goal is to maximise production, then Ricardo showed that specialisation and free trade was the way to go about it.

However, Smith and Ricardo assumed that the factors of production are perfectly mobile. How can a coal mine be changed into a computer factory, or miners changed into software engineers, without any extra expense? Their theories were also premised on full employment. Why specialise at all when you have resources standing idle? Regardless of these shortcomings, comparative advantage theory has shaped the world’s economy ever since. The World Trade Organisation (and its predecessor, the General Agreement on Tariffs and Trade) exists to rid the world of barriers to trade, assuming that world GDP will increase if production is specialised, and trade is free. The EU began as a free trade agreement between France and Germany with regard to steel and coal. Based on Ricardo’s comparative advantage theory, both countries believed their aggregate output could be increased through specialisation and free trade. Eventually, this evolved into the economic and political union of 28 states that we see today. The UK pays a great deal of money to the EU, but most economists argue that the gains to our GDP resulting from free trade more than outweigh our contribution to the EU budget.

What does free trade have to do with migration?

The EU insists on free movement of people within its member states. This is because if countries and firms want to maximise production, then free movement of labour is essential. National borders are seen as barriers to the labour market. If a company in Sweden identifies an Italian as having the expertise they need to expand production then being unable to hire her would stymie that company’s growth. If an entrepreneur in Bulgaria cannot find the capital to begin a business, or identifies a niche in a foreign market, then she should be allowed to travel in order to set up production. Comparative advantage theory is undermined by forcing workers to stay in their home country. In the hypothetical example above, a cloth maker in the UK would find themselves unemployed unless they could retrain as a wheat farmer. The EU believes it makes more sense to allow them to move to France where cloth production had expanded. More pertinently, if steel workers in the UK are getting laid off because it has become cheaper to import, they should be allowed to move to wherever steel production is thriving, to match their expertise to the location in which steel can be produced most efficiently.

It is a constant puzzle that many of those on the political right, who believe most vehemently in free markets and free trade, are often the most anti-immigration. This is an incoherent ideology. You cannot believe every market should be free from government interference except the labour market, because preventing workers to move to where their expertise is required hurts them, and it hurts the company who would benefit from their work. This is why many in both the leave and remain campaigns predict that leaving the EU will not affect net migration. Most in the leave campaign hope for an independent UK to sign a bilateral free trade deal with the EU, like Norway and Switzerland have. But there is simply no way the EU would sign this deal without an agreement on the free movement of workers. Both Norway and Switzerland agreed to free movement of workers as part of their trade deals. Why bother specialising in trade if you do not allow the market to allocate resources (in this case workers) to the right place?

But hasn’t the EU overstepped the mark, increasingly making political decisions that have nothing to do with free trade?

You cannot separate the economic from the political. A free trade area must set a common external tariff. This means that goods are taxed the same to enter the free trade area in every member country. If, for example, Ireland had lower tariffs on American imports than the rest of the EU, then the rest of the EU would be undermined. The Americans could move their goods into Ireland and then move them freely across the entire EU. The external tariff must be the same for every member state. So if the UK was to leave the EU, but then sign a bilateral free trade agreement with it, then the UK would still have to sign up to the common external tariff. It could not make its own trade agreements with the rest of the world.

Tariffs are not the only barriers to trade. Let’s say one EU state passes stricter emissions standards, to protect their environment. This too can be seen as a barrier to trade: they might not be taxing imports but the government is changing the standard of imports it will allow. The same problem still applies. Companies could simply move their goods into an EU state in which lower emissions standards applied, and the goods would be allowed to move freely within the entire free trade area. To take another example, what if one state decided to massively subsidise its car industry. Because of tax breaks and state handouts to car manufacturers, they could then sell their vehicles significantly cheaper than their rivals in other countries. This practice undermines free trade, because it forces rival countries to either begin their own subsidies, or lose out on sales. Similarly, what if one state passes a law stating that workers have no rights whatsoever. This might be useful for the government in question: companies would realise that it was cheaper to set up shop in that country because their wage bill would be significantly lower, and this might increase tax receipts. They would set up sweat-shops which would significantly increase their profit margin, or allow them to sell their goods cheaper and gain a competitive advantage over their rivals. However, like with subsidised industry, this is no longer a level playing field. The typical response to such moves is to enact retaliatory tariffs. If one country feels another isn’t playing by the free-trade rules, and is trying to give its firms a competitive advantage, then it will tax imports from that country.

The EU would not let trade wars like this begin, so it enacted fixed standards on emissions, on subsidies, on workers’ rights, and on numerous other issues. This is why the EU is seen as such a massive bureaucracy. It has no choice but to equalise standards across the entire free trade area. When the right-wing press run headlines about ‘Brussels interfering’, it is usually because they are ensuring that the same standards must be enacted across the whole EU. An independent UK, if it were to sign a free-trade agreement with the EU, would still have to abide by such standards. There would be just as many ‘Brussels interfering’ headlines.

Independent countries are far more likely to enter a ‘race to the bottom’ on standards. The government of an independent UK might be tempted to reduce workers’ rights, or to remove standards on emissions, or to allow the US to export hormone-injected beef, or any number of other things. It is tempting for one independent country to lower standards because this makes it more likely foreign firms will locate or invest. Of course companies want to manufacture goods which aren’t energy efficient. Of course they want to pay their staff as little as possible. Of course they want to be allowed to pollute. All of these things allow for cheaper production. A country offering cheaper production costs will attract more foreign companies to locate and invest… but at what cost? Companies are never going to snub the EU because of such standards: it’s too big. No firm would risk losing out on such a huge market. By combining their power to set standards, the 28 countries have avoided the ‘race to the bottom’ they may be in otherwise, allowing the EU to make significant progress in workers’ rights, on environmental standards, and in many many other areas. Once you have a free-trade area, it is inevitable that this will result in a convergence of standards. You cannot separate the economic from the political.

Don’t the EU focus too much on individual human rights?

No. Anyone promoting this argument is getting the EU mixed up with the European Convention on Human Rights, part of the Council of Europe, which is an entirely separate institution. The Council of Europe was set up after World War Two to promote human rights and ensure another holocaust was impossible. The UK joined the Council of Europe as a founding member in 1949, twenty-four years before it joined the EU. Even if the UK left the EU, it would remain a member of the ECHR and Council of Europe. It is staggering how often seemingly well educated politicians and pundits mix up the EU and the ECHR.

And finally…

Free trade stops wars. This is surely the argument which trumps all others. Europe experienced regular warfare for centuries before the EU came along, and has experienced relative peace ever since. There is a body of evidence built up around the world and over centuries which shows that countries who trade with one another are far less likely to go to war. That is established fact. The flaws in comparative advantage theory and people’s worries over migration surely pale into insignificance by comparison.

In Conclusion

I cannot understand why people would vote leave only to then sign a bilateral free-trade deal with the EU. We would still have to follow all of its rules – on free movement of labour, external tariffs, environmental standards, workers’ rights etc – but we would have no input into changing those rules. There is nothing to be gained from leaving the EU and signing a bilateral free trade agreement.

Leaving the EU without signing a bilateral free-trade agreement would be risky in the extreme. It is our biggest market for exports, and many firms would struggle if they suddenly had to pay tariffs on their goods. Inevitably, some firms would go bust and jobs would be lost. Other firms would relocate to an EU member state. The amount of companies choosing to locate here in the future would decrease. In the short-term it would be catastrophic for businesses. Eventually, our economy might rebalance. New markets might be found or companies might adjust to the increased cost of exports, but I am pretty pessimistic about this scenario.

The EU clearly has problems. Monetary union was a bad idea. Its treatment of Greece has been shameful. Despite the increased prominence of the European Parliament, it still has a democratic deficit (for example, look at the power the German finance minister has over the whole of Greece). However, I can’t help but believe that we should be part of it, helping to solve these problems, rather than watching from outside. I don’t like to think of us as a parochial, insular people. It seems wrong to me to retreat back onto our little island and letting the rest of Europe get on with it without us in the room. It seems wrong to me to not allow students to take a bar job in Kos unless they can get a visa. It seems wrong to me to tell people they can’t retire on the Costa Del Sol if they want to. It seems wrong to me to tell the 1.2 million British people living and working in the EU that they have an uncertain future, and may be forced to come home against their will. Above all, it seems wrong to me to abandon an institution that ended the centuries of wars Europeans fought against each other. I’ll be voting to remain.